00:29:58 · Ed Elson
[00:29:58] S4: We're back with Prof G Markets. Last week's earnings reports from Microsoft and Google gave investors a look at how two of the biggest players in big tech are performing, and the market's reaction could not have been more different. Microsoft shares jumped as much as 5% after the company beat expectations with revenue up 19% year over year. It also disclosed Azure revenue in its earnings statement for the first time, revealing that its cloud business grew 48% from a year earlier. Google shares, meanwhile, dropped more than 13%, wiping out $500,000,000,000 for its worst market cap loss ever. That pain came despite reporting 25% revenue growth in the third quarter. Investors were disappointed by weaker than expected search and advertising revenue and negative free cash flow. Scott, really interesting week for the hyperscalers because we have the Anthropic s one, which came out, which has polarized a lot of people as to whether that was great or whether that was bad or something in the middle. But then also we have these big tech earnings coming out. Microsoft was great. Investors are very happy about it. Google's... On the surface, like, not terrible, I thought, at least from a revenue perspective, but investors were very, very freaked out about this idea that search revenue growth is beginning to decline and all of the fears that we that we were hearing about, I would say, two years ago, basically when ChatGPT was starting to to gain steam, suddenly those fears have come back where investors are saying, oh my gosh. AI is going to kill Google search. That plus the fact that their free cash flow is negative, and they're plowing more and more money into the AI data center, something we're also seeing from Meta, something we're also seeing from Amazon. What do you make of of this week in big tech land?
00:31:52 · Scott Galloway, Ed Elson
[00:31:52] S0: I thought it was pretty shocking, and it's sort of the tale tale of two cities. It's the same AI arms race, but entirely opposite verdicts. Microsoft was up 5% on cash flow discipline, and Alphabet down double digits on cash burn. And the way I would describe it is both companies had amazing year on year revenue growth and really outstanding businesses. But I think it's two things that punished, Microsoft was able to thread the needle here. And that, as I said, we're gonna surprise to the upside on the top line and the bottom line. And what I think really excited people is their CapEx looked fairly disciplined. Now granted, it's still unbelievable. It's still out of control, but it looks fairly disciplined. [00:32:35] S4: Compared to the alternatives.
00:32:37 · Scott Galloway
[00:32:37] S0: Yeah. And compared to Alphabet. Yeah. And when Alphabet's executive admits on the earnings call that AI mode generates fewer ads, it's like the company confessing its flagship product cannibalizes its core business. So AI is a profit center that needs to be managed well for Microsoft in terms of CapEx. AI needs to be a profit center for Alphabet that needs to be managed well. It doesn't look like the CapEx was managed as as... In as disciplined a fashion. In addition, AI is an existential threat to Alphabet because the world's most profitable, largest tollbooth in history, search, is... It appears like is kind of under attack. I don't know about you, but I think there's probably a lot of analysts listening and hearing seeing... Hearing the numbers. They see the CapEx of a company growing its AI business. But what they don't see or what they also see is that AI is an existential threat to their ability to generate the cash flow they need for CapEx for the arms race. And the anecdotal evidence, I don't know if you find this, I am now doing basic search on on Claude. And at some point, that's just gonna show up in the in the numbers. But my... What Microsoft did here was unbelievable. Microsoft renovated with cash on hand, and Alphabet appears to be taking out second mortgages, you know, for the same renovation, which is gonna result in kind of a different call from the bank, if you will. So really two divergent results here. And the largest market cap erosion, single day market cap erosion in the history of the company,
00:34:11 · Ed Elson
[00:34:11] S4: that's a big deal. I'm less worried about the search revenue because I see the fact that it's growing, and it it grew less than investors had expected. I think that the reason there was such an allergic reaction on that front is that this is the boogeyman for the markets. This is the thing that they're obsessed with. Will chat GPT kill Google? And we saw them have a a premature reaction several years ago, which is when we went in and said, this thing's gotten over punished. So they've been... Their antennae are up on this big question. And so as soon as they see even an inkling of a sign that maybe something bad is happening, suddenly they freak out and they panic about the whole situation. For me, I'd wanna see... I would wanna see more concrete evidence that that's actually happening. Like, I'd wanna see their their their search revenue flatline or even decline. That's something that would make me more confident in this idea that ChatGPT is going to to to eat Google's lunch. But then again, at the same time, Google also has Gemini. And so I I think they've actually kept up, on on this on this AI race quite well. But I do think that the real problem in my view is that negative free cash flow. And to be clear, Google is not alone there because we also know that Oracle's free cash flow is negative. Meta's free cash flow is negative now. Amazon's free cash flow is negative now. All of the hyperscalers have now entered into negative free cash flow because of how much money they're spending on the data centers. It's it's nearly $700,000,000,000 on CapEx in the past twelve months. That's up nearly 90% from a year ago. The only hyperscaler with positive free cash flow is Microsoft, which is great, but it still came down 27%. So the thing that worries me is the fact that these businesses can no longer use their profits to finance their goals, which is in this case to build data centers and build the AI revolution. And so you think about, okay. Well, what can they do then if the most profitable companies in the world can't even use their profits to do whatever it is that they wanna do? Well, then you'd say, okay. They can go to the cash on their balance sheet. And that's what a lot of people have pointed out. And to be fair, these guys have a lot of cash on hand.
00:36:32 · Ed Elson
If you look at their cash and cash equivalents and their short term investments, you got Amazon with more than a $120,000,000,000. You got Google with more than $250,000,000,000. If you add all the hyperscalers together, it's nearly $600,000,000,000, which is great. But then you look at how much CapEx is going to rise next year and the year after that. And if you add it all up among the hyperscalers, the five of them, Oracle, Microsoft, Meta, Amazon, Google, over the next two years, it's estimated to be more than $2,000,000,000,000. So, basically, what you have is is is like a $1,500,000,000,000 gap between how much money they're going to spend and how much money they actually have. Because remember, they can't use the profits anymore because... Or the cash flows because those cash flows are negative. So they have to get the money from somewhere else. And so then you think, okay. Where is that money gonna come from? And the answer is they have to go to the capital markets and raise money. And that's why I was really... Like, yeah, it felt really powerful that literally the day after Microsoft reports their earnings, they also announce a $25,000,000,000, bond sale. And that's just a week after Meta said, we're gonna go raise $95,000,000,000 in the equity markets. So what it was so great about these companies is how independent they were for so long. They were so strong, so profitable. They could do whatever they want. Who gives a shit about the market conditions? They don't need our money. But that has now completely changed. They need money from the capital markets. They need money from us, the investors. And if we decide that we don't wanna give them that money, then they're screwed. They're just in a systemically more vulnerable position. And that to me is the real shift in what's happened here for big tech. There used to be these dependent... Or, excuse me, independent companies do whatever they want, but now they have to go out there and they have to please investors and they have to convince them, don't worry. Give us the money. We'll pay it back. We can we can raise it through the bonds. We can raise it through the equity, but just play the game with us. They're dependent on the capital markets now.
00:38:50 · Scott Galloway
[00:38:50] S0: I think of an historical analogy here around the AI arms race is impacting everyone. And I think of... So, basically, we were in an arms race, an actual arms race with the Soviet Union. And we had the economy and the growth and the capital to win. And we basically... The Soviet Union employed it on itself because it couldn't keep up with this type of military or defense spending and and poor leadership and an autocracy, etcetera. And it collapsed on itself, and that resulted in kind of a forty year run as the world, you know, of of hegemony where basically The US was the only game in town. Everyone is in an arms race right now. And, yeah, the the companies are starting to say, alright. Who... Who's gonna survive? Who has the underlying capital to survive? Now to your earlier point about Alphabet, every time in Alphabet's history, you've had this sort of check back, it's been a buying opportunity. And kind of pregnant with your comments is a really interesting question, and that is, is this a buying opportunity? Because if you look at Alphabet's PE right now, it's 14.6 versus the S and P at 19.5. Take your average S and P company, Caterpillar or P and G. These are great companies, Monza, whatever it is. You know, they're not Alphabet. YouTube is on fire. Google search, every time we keep... You know, rumors of its death have always been greatly exaggerated. I don't know what it was up. It's always up double digits. They have a booming cloud business. They have... If there's an agentic layer that emerges, they have relationships with millions of businesses and billions of consumers to start bridging the gap and start eating OpenAI or Anthropic launch, and it's trading at a lower PE multiple than your average S and P company. And, obviously, when you look at how robust this business is, how diversified it is, how well run it is, the concentration of IQ there, I don't know. This to me feels like a buying opportunity. Your thoughts?